The Scampini Supplies Company recently purchased a new delivery truck. The new t

Question

The Scampini Supplies Company recently purchased a new delivery truck. The new truck cost $22,500, and it is expected to generate net after-tax operating cash flows, including depreciation, of $6,250 per year. The truck has a 5-year expected life. The expected salvage values after tax adjustments for the truck are given below. The company's cost of capital is 10.5 percent.

What is the optimal number of years to operate the truck?

Year Annual Operating Cash Flow Salvage Value 0 -$22,500 $22,500 1 6,250 17,500 2 6,250 14,000 3 6,250 11,000 4 6,250 5,000 5 6,250 0

Explanation / Answer

The approach for this question will be calculating NPV for each year based on the given cost of capital of 10.5%.

Given data, Initial cash outflow(cost )(IN) is $22,500. Cash inflow each year is $6,500 and the expected life of the truck is 5 years. Present value of cash inflow are given below

Cumilative inflow (CI) Salvage value(SV) Net Flow(CI+SV-IN)

Year1 6,250/(1.105)=5,656.109 5.656.109 17,500 656.1086

Year2 6,250/(1.105)^2=5,118.65 565.109+5118.65=10,774.76 14,000 2,274.759

Year3 6,250/(1.105)^3=4,632.263 15,407.02 11,000 3,907.022

Year4 6,250/(1.105)^4=4,192.093 19,599.11 5,000 2,099.115

Year5 6,250/(1.105)^5=3,793.749 23,392.86 0 892.8639

In the above table look at the last column, It is the netflow to the firm at each year. Since third year is having maximum net flow, 3 years is the optimal number of years to operate the truck.

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